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Stock Strategist

Costco's Bulking Up Its Moat

Its loss-leader capabilities should drive unrivaled sales per square foot and excess returns.


 Costco (COST) reported second-quarter results that were slightly below our expectations on the top line, and margins were also a bit weaker than we expected. However, a closer look at the results leaves us confident that Costco's bargaining power, highly efficient operations, and loss-leader capabilities will allow the firm to outperform many retail peers, and we are maintaining our narrow Morningstar Economic Moat Rating with a positive trend, as well as our $120 fair value estimate.

Comps increased 2% during the period, driven by a 3% increase in the U.S. and a 1% decline in international markets. However, U.S. and international segment comps were up a solid 4% and 5%, respectively, after adjusting for lower gas prices and exchange rates. These comps are much better than those posted by other retailers, again suggesting that Costco remains in a good position to leverage its cost advantage to strengthen its perceived cost leadership, which drives a brand intangible moat source by helping Costco raise membership fees and keep renewal rates in the mid- to high 80s. On the basis of management's commentary, it appears that most of the underperformance occurred in the period leading up to the holidays. We aren't surprised that performance was weak during this period, given how competitive the holiday season was, and we are confident that Costco can sustain mid-single-digit comps long term.

Ken Perkins does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.